People often ask: “What is Escrow And How Does It Work”.
An escrow is a contractual relationship between three parties. In a sales transaction, the buyer deposits funds into the custody of a third party who holds them until the buyer and seller complete all requirements.
A formal definition of “escrow” is the holding of something of value (usually money) and/or documents by a neutral third party until completion of contractual obligations.
Sellers and buyers use escrows for all types of purchases such as the sale of expensive artwork, vehicles, vessels, commodities, and securities.
The focus of this article will be on real estate escrow transactions when explaining what is escrow.
The Need for Escrow
In the old days, sellers would agree to sell their real property to a buyer. The buyer pays the seller who then delivers a written document transferring ownership to the buyer.
Alas, these transactions often went wrong. Sometimes, the seller didn’t even own the real property. He or she pretended to be the true owner, took the buyer’s money and disappeared.
Other times, the buyer received the title transfer but didn’t pay the seller. Often, buyers tricked sellers into giving them a deed. Sometimes, buyers paid with counterfeit money, wrote bad checks or used forged signatures.
These problems made people search for ways to make the process safer for both parties. Eventually, the idea of hiring a neutral trusted third party to hold the funds and to deliver the required documents came to fruition.
History of Escrow
Escrow derived from an Old French term “escroue” during the Middle Ages of the 11th and 12th centuries. A parchment scroll became a title deed that the escrow agent held until the sales transaction completed.
The English began using the word “escrowl” in order to describe a scroll when translating French into English. The written scroll was a checklist of things the seller and buyer needed to do in order to complete the transaction.
Escrow in the U.S.
The popularity of escrows in the U.S. occurred during the Great Depression of the 1930’s. Due to many Americans losing their homes for failing to pay their property taxes.
The forerunner to modern day escrow originated when lenders agreed to collect 1/12th of the annual property taxes with the monthly mortgage payments. These so-called “forced savings” escrow accounts became popular as millions of homeowners spread their property tax payments over a year instead of one lump sum.
1934 saw the creation of the U.S. Department of Housing and Urban Development (HUD). Eventually, HUD regulated escrow accounts nationally with the Real Estate Settlement Procedures Act (RESPA) in 1974. RESPA lenders must meet specific requirements in order to handle escrow funds.
Escrow in the State of California
The State of California allows two types of escrow companies: “Controlled” or “Licensed”.
“Controlled” escrow companies operate without an official license because they are owned by companies already licensed within their professions. Examples include real estate brokerages, banks, title insurance companies, savings and loans, and mortgage brokers.
“Licensed” escrow companies are independent companies licensed by the California Department of Business Oversight (DBO).
The California DBO requires escrow companies (escrow agents) to be incorporated in the State of California, file a fidelity bond covering every employee, post a surety bond, prove sufficient solvency, and become a member of the Escrow Agents’ Fidelity Corporation (EAFC).
Escrow officers employed by an escrow company must obtain state certification.
California Escrow Law
The California Escrow Law is found in the Financial Code (Division 6), beginning with Section 17000. The regulations issued after this law was enacted are found in Title 10 of the California Code of Regulations (Subchapter 9), beginning with Section 1700.
The California Financial Code defines escrow as “…any transaction in which one person, for the purpose of effecting the sale, transfer, encumbering, or leasing of real or personal property to another person, delivers any written instrument, money, evidence of title to real or personal property, or other thing of value to a third person to be held by that third person until the happening of a specified event or the performance of a prescribed condition, when it is then to be delivered by that third person to a grantee, grantor, promisee, promisor, obligee, obligor, bailee, bailor, or any agent or employee of any of the latter.” in Section 17003(a).
In simpler terms, California defines “escrow” as a legal transaction involving the sale, lease, transfer, or encumbrance of personal or real property to another person. In return of money or anything of value, the seller promises to deliver a title deed or another written document to a third party to hold until the other person meets all conditions. When the conditions are met, the third party delivers the deed or written document to the other person or his/her agent.
Escrow Assisted by Professionals
Typically, a real estate escrow process involves professionals in addition to the original three parties. Real estate agents (representing the seller and/or buyer), title insurance issuers, property inspectors (surveyors, home inspectors, etc.), attorneys, lenders, and sometimes accountants, all work with the escrow officer.
After completion of the title search, inspections, loan approval, and seller’s payment of all property debts; the escrow is ready to “close”.
Before the real estate transaction closes, the escrow officer distributes all of the documents and funds to the appropriate parties. Then, the deed is recorded with the appropriate government agency. Once title passes to the purchaser, the escrow is closed.
What Is Escrow And How Does It Work Conclusion
The question, “What is Escrow?” is answered here.
An escrow involves hiring a trusted third party to hold funds and documents for the two parties of a purchase contract until they complete the contract.
A real estate escrow involves the sale of real property with the third party holding funds and documents until the other two parties perform as their contract requires.
The State of California enacted escrow laws to protect both the buyers and sellers. The state also requires escrow companies to be solvent, insured, licensed and only hiring escrow officers who are educated, trained, and certified.
The escrow laws across the nation are some of the strongest Consumer Protection types of laws in the world.
Steven Rich, MBA – Guest Blogger
We hope you like “What Is Escrow And How Does It Work”. To learn more about the escrow industry check out one of our many Blog Pages.
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